Reference no: EM133106568
Question - Leaton Co introduced a new product, LD to its range last year. The machine used to mold each item is a bottleneck in the production process meaning that a maximum of 7000 units per annum can be manufactured.
The LD product has been a huge success in the market place and as a result, all items manufactured are sold. The marketing department has prepared the following demand forecast for future years as a result of feedback from customers.
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Year
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1
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2
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3
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4
|
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Demand (units)
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8000
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10000
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12000
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6000
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The directors are now considering investing in a second machine that will allow the company to satisfy the excess demand. The following information relating to this investment proposal has now been prepared:
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Initial investment
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$30000
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Maximum additional output
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7000 units
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Current selling price
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$80 per unit
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Variable operating costs
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$36 per unit
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Fixed operating costs
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$18000 per year
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If production remained at 6000 units, the current selling price would be expected to continue throughout the remainder of the life of the product. However, if production is increased, it is expected that the selling price will fall to $72 per unit for all units sold. Again, this will last for the remainder of the life of the product.
No terminal value or machine scrap value is expected at the end of four years, when production of LD is planned to end. For investment appraisal purposes, Leaton uses a nominal (money) discount rate of 12% per year and a target return on capital employed of 22% per year. Ignore taxation
Required -
(a) Calculate the following values for the investment proposal.
(i) Net Present Value;
(ii) Internal Rate of Return;
(iii) Return on Capital Employed (Accounting Rate of Return) based on initial investment; and
(iv) Discounted Payback Period
(b) Discuss your findings in each section of (a) above and advise whether the investment proposal is financially acceptable.